Tariffs Could Lead to Red Ink

China announced Monday it was going through with a 25% increase on tariffs against an array of U.S. agricultural products, including pork. That sent hog futures limit down on some CME contracts. (DTN file photo)

OMAHA (DTN) -- U.S. pork producers had ramped up production in the first quarter of this year, but futures prices continue to fall as China announced Monday it was moving ahead with a 25% increase in tariffs on fresh pork products.

The tariff hikes come after leaders from Chinese-owned Smithfield Foods -- responsible for three-quarters of U.S. pork exports to China -- downplayed the potential impact on the company's bottom line in an analyst call and television interview last week.

Producers have seen prices fall roughly $30 a head since mid-February. The nearby contracts on the CME for lean hog futures were limit down or close to it on Monday as the market reacted to the news.

China moved ahead Monday with tariffs on 128 products, accounting for roughly $3 billion in sales, according to USDA's Foreign Agricultural Service. Pork tariffs jumped from a range of 12%-20%, depending on the product, to 37% and as high as 45%.

The one major commodity left untouched by Monday's announcement was soybeans.

DTN Livestock Analyst John Harrington noted the tariff hikes come as pork producers have been in expansion mode with the overall pork inventory over the last quarter up 3% from the same time last year. That higher production was well-anticipated, but still pretty aggressive, Harrington said. "We've got the pedal to the metal here as far as expansion goes, he said" That higher production will now put producers under pressure if demand slacks.

"Everybody is expanding pretty aggressively," Harrington said. "If they can't sell the pork and it gets stored, the prices are $50 now, probably heading on its way to $40. There's going to be a lot of red ink, among just producers."

Last week, Smithfield's parent company, WH Group, reported 2017 annual results, and executives took questions from analysts about the company's performance and the possible impact of tariffs. Smithfield reported it was responsible for 75.9% of U.S. pork exports to China last year.

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The U.S. Meat Export Federation notes the U.S. exported $1.1 billion of pork to China ($663 million) and Hong Kong ($415 million). It's unclear how much Smithfield sends specifically to Hong Kong versus other ports, but Smithfield's share of the market would range between $503 million to $817 million based on the information from WH Group.

Ken Sullivan, president and CEO of Smithfield Foods, told analysts not to overreact to tariffs. He noted only 5% to 7% of Smithfield's total fresh pork production was exported to China. Before the tariffs were officially imposed, Sullivan told Bloomberg TV last week that the market reaction to possible Chinese tariffs had been "almost hysterical."

"Certainly, you have to recognize it would make shipments from the U.S. to China more expensive," Sullivan said, adding that China was just one market.

Sullivan noted that WH Group's earnings are weighted heavily in the package-meats business. He suggested to analysts that tariffs would bring down the cost of production in its packaged-meats plants.

"If there were tariffs placed, that would place pressure on the fresh-pork business in the U.S.," Sullivan told analysts. "That would have lower raw-material costs for our packaged-meats business. Already, I'm seeing that our packaged meats business in 2018 should have a pretty strong year because of meat values, and certainly, well, I'd leave it at that."

Sullivan also told Bloomberg only 2% of domestic consumption is imported, and the U.S. only comprises about 15% of that market. Roughly 75% to 80% of Smithfield's exports to China are also in the variety meats category, stomachs and livers and snouts and things of that nature that, again, Americans don't eat."

The U.S. Meat Export Federation said China was the largest market for variety meats in both volume and value at $741.8 million, or roughly 63% of the value of U.S. pork shipped to China and Hong Kong last year. Those variety meat exports equated to adding roughly $6 per head to each U.S. hog slaughtered.

Sullivan told Bloomberg that a tariff would cut into the company's profits and noted that the Chinese market is still important to the U.S. "And I'm also not suggesting that somehow we should be cavalier about tariffs," he said. "We shouldn't. We're free traders. We believe in it."

He added, "We may very well ship to China with an increased tariff."

Harrington noted Smithfield has roughly 900,000 sows, and due to that, "They've got more than a little vested interest in what the hog market is in the U.S.," he said.

Smithfield's profit center of packaged meats may look more attractive, but the lower hog values will come back to affect the company as well, Harrington said.

"A majority of their sales are domestic, and they are going to be hurting along with the rest of the pack, I think," he said.

It's difficult to get accurate numbers out of China, but Chinese farmers in recent years also have overshot on their production and domestic pork prices in China are the lowest in four years, Harrington said.

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